Crowdfunding creates more opportunities for entrepreneurs

August 7, 2013

As discussed in last month's column, one of the ongoing concerns for many new and existing businesses is financing. As the availability of bank loans and other traditional sources has become more scarce in recent years, entrepreneurs have been searching for new ways to finance their ventures.

One of the newer sources is called crowdfunding, also known as crowd financing. Crowdfunding is a group of people who were recruited to pool their money, usually by social media, to finance a new business, new product or other efforts initiated by a business or other organization. Crowdfunding is not limited to businesses. Crowdfunding spreads the risk across a larger number of investors and creates a group of supporters for the endeavor being funded.

It is different from angel investing or venture capital financing because of the large number of backers. The business is not obligated to one or to a small number of investors who may want some control of the project or business being supported. Some of the larger crowdfunding sites in operation are Wefunder, RockthePost and Kickstarter.

Organizations using crowdfunding to finance their ventures are not allowed to offer equity positions to investors.

At a recent Small Business Administration conference, an inventor of a new smartphone application discussed how offering a prototype of the product he we was developing helped attract more funding than he needed in just a few hours.

A restaurant owner at the same conference discussed how he gave a free meal at the restaurant to anyone investing $100 or more. The key is to find an incentive related to the product or business that also is attractive to potential investors.

The problems associated with not being able to offer equity to investors may be going away soon. The Jumpstart Our Business Startups Act, or JOBS Act as it is commonly known, was passed by Congress and signed by President Barack Obama in April 2012. Its purpose is to relax security laws to make it easier for smaller businesses to secure funding.

Many believe the law will open the door for crowdfunding investors to acquire shares in the ventures they fund. The Securities and Exchange Commission has not yet determined the details of the law or exactly how it would apply to crowdfunding, though.

If implemented in its current form, the JOBS Act will enable organizations to raise up to $1 million without having to go through the more complex process of a public stock offering. It appears the act will only apply to C corporations wanting to use crowdfunding. S corporations, a popular form of ownership for small businesses, are limited to 100 shareholders. This could severely limit the number of investors in any one crowdfunding project and limit the amount that could be raised.

Most of the organizations successfully using crowdfunding have created short video presentations of their proposition to post on the crowdfunding site. The site needs be to monitored and may need to be changed based on the feedback received by those who visit the site.

Organizations using crowdfunding to raise money also need to be prepared to answer questions posed by potential investors. They may want to know the details about where, when, why and how the funds being asked for will be used.

Potential investors are attracted to an organization's crowdfunding proposition in several ways.

First, there is a group of investors who visit these crowdfunding sites on a regular basis. Second, other social media are used to drive potential backers to the site. For example, if an organization has fans on Facebook, these fans are a good pool of potential investors and need to be directed to the crowdfunding site through the Facebook account or the organization's web site.

As social media develops and government continues to change the rules concerning how it can be used, crowdfunding appears to be a very attractive source of funding for many entrepreneurs and other organizations.

Perry Haan is professor of marketing and former dean of the business school at Tiffin University. He can be reached at (419) 618-2867 or haanpc@tiffin.